FRDI Bill: What it means for banks and their depositors

The Financial Resolution and Deposit Insurance (FRDI) bill was pitched by the Lok Sabha in August, 2017, with the sole intention of protecting financial institutions from going bust and bringing in orderly regime in financial firms.

But it seems to have caught many on the wrong foot.

Most are struck by the fear of losing their money in case of implementation of Clause 52, which states that it may come to use depositor’s money (bail-in) as a resolution mechanism for banks that run into financial trouble.

But overall, the purpose of the bill and its larger implications have been a little misunderstood.

Let’s get an insight into it to understand the implications on your personal finance.

Purpose of the Bill is to protect banks

The bad loans scenario in India is worrisome with 12 companies accounting for 25 per cent of NPAs as of 2017.

While there is a legal framework to bring in a resolution regime in non-financial firms, currently there is no such system in place for failing financial firms.

The ministry has proposed this bill to bring in a regime to detect insolvencies and bring in orderly resolution in financial firms.

As per the draft work, a resolution corporation will monitor the financial companies, categorise them as per their risk profiles and intervene if there’s a possibility for bankruptcy by writing down their liabilities.

This bill has been pitched in a move to especially protect the private sector financial firms from going bankrupt.

This is a much needed framework in the current scenario where the Reserve Bank of India has declared 11 banks under the Prompt Corrective Action List (PCA).

PCA takes into account certain regulatory trigger points, as a PCA Framework, in terms of three parameters, i.e. capital to risk weighted assets ratio (CRAR), net non-performing assets (NPA) and Return on Assets (RoA), for initiation of certain structured and discretionary actions in respect of banks hitting such trigger points.

The resolution process

This involves setting up of a corporation with members representing all financial regulators, which will oversee the resolution of a failing firm.

The corporation will classify the risk levels of firms as low, moderate, material, imminent and critical.

Now, based on the risk profile of a firm, the corporation will decide whether to intervene or not.

The resolution methods include merger/acquisition, bail-in, transfer of a sick entity’s assets and liabilities to a third party, forming a bridge company to control these assets and liabilities, and liquidation.

Understanding the bail-in tool

Bail-in has been proposed as one of the resolution mechanisms in Clause 52 for sustainability of a failing financial firm.

This means that the corporation has been vested with the power to liquidate depositor’s money in case of bankruptcy.

This proposal has led to anxiety among depositors.

In an effort to pacify the misgivings expressed by depositors, the government has reassured that the public sector banks are well out of the radar as such emergencies are not likely to arise in them because the government takes care of the capital needs of these banks.

On the other hand, this tool will serve as the last resort in private sector banks only when a merger and acquisition is not viable.

Bail-in can also be invoked if you had given prior consent at the time of signing the deposit forms.

Safety net for deposited money

Currently the bank deposit in India is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) and the amount insured in a respective bank stands at Rs 100,000.

With the FRDI bill coming into place, the resolution corporation is likely to replace DICGC and a new insurance limit of more than Rs 100,000 is expected to be set.

This would protect a large number of depositors.

It will encourage smarter money moves

The government has been discouraging investment into traditional assets for quite some time in a move to divert investor attention towards other financial asset classes.

The notion of bank deposits being risky will only encourage depositors to explore diverse asset classes.

Mutual funds, bonds, PPFs, equity and real estate are some such options which offer varying rates of return.